Forex: US Dollar to Extend Gains if Yellen Defies Dovish Presumptions

Talking Points:

US Dollar Rebounds as Markets Digest Yellen’s Confirmation Speech
Aussie, NZ Dollars to Underperform if Yellen Disappoints Dovish Bets
Euro Likely to Fall if Eurozone GDP Data Falls Short of Expectations

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The US Dollar corrected broadly higher in overnight trade, erasing a plunge seen late in the North American session following the release of the speech to be given by Fed Chair nominee Janet Yellen at her confirmation hearing today. The Japanese Yen bore the brunt of the Buck’s advance as Asian stocks advanced, sapping demand for the safety-linked currency.

The markets seized on Yellen saying that unemployment is still too high, “reflecting a labor market and economy performing far short of their potential.” Investors already see Yellen as falling on the dovish side of the policy spectrum, and these comments seemed to reinforce the idea that her ascendancy would push a reduction in QE asset purchases further into the future.

The greenback’s dive was short-lived however as markets digested the remainder of the speech. Indeed, just a few sentences later, Yellen says a strong recovery will ultimately “enable the Fed to reduce its…reliance on unconventional policy tools such as asset purchases.” No specific definition of what a “strong recovery” looks like was given, leaving investors to wonder if a string of upside surprises on key US economic data releases (including ISM, GDP and NFP outcomes) this month fits the bill.

On balance, Yellen’s speech seems broadly in line with the Fed’s recent policy stance rather than the notable dovish departure from status quo that markets seemed to initially find therein. The onus is now on the Q&A session to follow herprepared remarks, where traders will hope to find a bit more color to help judge what her proclivities will be once in the driver’s seat.

Rhetoric marking a notable break from the FOMC’s status-quo message seems unlikely, but markets primed for a pro-stimulus argument may be disappointed. Such an outcome stands to offer further support to the US unit while weighing on risk appetite, with the sentiment-anchored Australian and New Zealand Dollars arguably looking most vulnerable among the majors.

The preliminary set of third-quarter Eurozone GDP figures headlines the economic calendar in European hours. Expectations call for output to expand 0.1 percent, marking the first slowdown in quarterly growth readings this year. News-flow out of the currency bloc has increasingly underperformed relative to expectations since late August, opening the door for a downside surprise that boosts bets on further ECB easing and drives Euro lower. We remain short EURUSD.

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